€STR CCP Delay on IBOR

*News Flash* Pandemic and market upheaval cause a 5 week delay to the June Euro IBOR switch

Clearing Houses that previously scheduled the IBOR discounting switch on 22nd June (from EONIA to ESTR, on Euro derivative contracts) are now delaying this change by five weeks to 27th July 2020. This was announced yesterday on Friday 17th April through the European Association of CCP Clearing Houses (EACH)*. It is believed EUREX and LCH have confirmed, with CME expected to follow suit.

This decision to delay by 5 weeks appears to have been reached after conversations with the Euro risk free rate working group, and after the European Central Bank (ECB) did not provide their own decision on a delay. The five week timeframe is a compromise, to provide more time for operational arrangements and testing, but not a longer three month postponement that may “jeopardize…[acting] in an orderly and unified manner”*.

Central Clearing Counterparties had previously stated they were operationally ready for the 22nd June milestone within the broader IBOR Transition schedule. However, industry working groups including those clearing members and the clearing houses themselves had recently consulted on whether to delay the ultimate deadline (Dec21), delay only the switch itself (Jun20) or to keep to the previous schedule.  Out of these three choices, it is unclear how the ultimate IBOR deadline could be changed due to the voluntary announcements and international complexity of the global IBOR Transition. The LIBOR panel banks and UK regulator have already agreed not to publish LIBOR rates post December 2021.  Further complication to an ultimate deadline delay would come from the various currency rates set by the London panel banks affecting agreed international financial contracts subject to different jurisdictional law (and then there is the impact of other rules such as EU Benchmark Regulation).

Yesterday’s CCP decision is a litmus test for whether other interim milestones will be delayed, and whether momentum is building to adjust the ultimate December 2021 deadline (in some manner).  The EONIA to ESTR switch is for clearing houses to make, affecting both their valuation on cleared Euro swap contracts, as well as interest paid on the posted collateral.  This particular switch is simpler than other rate switches due later this year (given the difference between the rates has already been fixed at 8.5bp). However, if this ESTR switch had been delayed by a full three months, it would have come precariously close to the EFFR to SOFR switch:  this would have meant two, closely scheduled, technically and operationally intrusive changes in quick succession. There is still a theoretical possibility that the EFFR to SOFR switch may also be delayed, as a knock on impact.  Further information on these CCP changes is available on previous post (IBOR Changes: Swaps).

Within the broader context, as recently as 25th  March, the FCA had made clear in light of coronavirus impact that firms still should “[not] rely on LIBOR being published after the end of 2021…..[and this] should remain the target date for all firms to meet……. There has, however, been an impact on the timing of some aspects of the transition programmes of many firms….[and] it is likely to affect some of the interim transition milestones”.  Alongside  CCP scheduled switches, other milestones include (i) the restriction to enter into or launch new cash and derivative contracts (beyond Dec21), (ii) the prohibition of trading these contracts by Government Sponsored Enterprises (GSEs such as Fannie Mae and Freddie Mac) and (iii) commercially discouraging haircuts on the use of these contracts as collateral (for example through Bank of England facilities).

Yesterday’s announcement to delay the EONIA to ESTR switch will give market participants more room to breathe, but it may also start sowing seeds of doubt on the EFFR to SOFR October 2020 switch.  However, by mid-year, the industry should be used to the new ways of working, and the dust may have settled on how ARRs have performed comparatively, in the first quarter’s volatile markets.  Beneficially, it also provides more time to consider who out of the various trading desks within the Banks should own and manage the basis (more on this in the next IBOR blog).

More information on the IBOR Transition as well as  IBOR Readiness Strategies is available upon request.

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